Thursday, November 5, 2015

Did Bernanke (And Crew) Save The World?

I have not yet read Bernanke's new book, The Courage to Act, but plenty of people on both the left and the right are mocking claims made by many that Bernanke and crew "saved the world" by their actions in September, 2008. Most of the focus of these discussions has been on the TARP bank bailouts along with the creation of a bunch of special lending entities, most of which were shut down later. Those on the left tend to argue that we would have been better off letting some more big banks fail, along with throwing at least their CEOs and CFOs in jail. Those on the right worry about all the moral hazard hyped up by TARP as well as the more than doubling of the Fed bank balance sheet that happened in the next few months, going from roughly $900 million to about $2.2 trillion by thge beginning of 2009, with this supposedly setting us up for that hyperinflation that is still supposedly going to come some day.

"Save the world" is awfully dramatic, but indeed the buzz by those defending Bernanke has been that this moment was like September, 1931, when the rolling international financial collapse that had started in May of that year in Vienna with the failure of the Creditanstalt finally hit the US shores hard, and the Fed did nothing, with this being reported and criticized by Friedman and Schwartz in their Monetary History of the United States, the work much on Bernanke's mind and to which he has referred, even famously promising Friedman at one point that he would never let that happen again, the failure to prop up the banking system in September, 1931, which indeed was followed by a massive wave of bank failures, and a severe plunge of the US economy into the Great Depression. If he saved the world, it was that he prevented that. But many are skeptical, particularly with regard to TARP and the assoicated bailout of AIG. The bums should have been shut down and jailed.

I have reported on this previously, but I think have again become aware of how few people understand what really went down in September, 2008. We just had a well-known economist in yesterday, who will remain unnamed, who when I told him what really went down dismissed the whole thing as "a conspiracy theory." It can sound like it if one does not know about it. But in fact this was a successful conspiracy that has been since made public, but about which many seem not to know, including professional economists who really should know better, even if they would still disapprove of it.

So, the most crucial action was not TARP or the AIG bailout. It was the decision on September 18, 2008 to open swap lines to foreign central banks, especially the ECB, which were under heavy pressure and facing a complete freeze of their financial markets due to a plunging euro and lack of dollars. This is recounted in Chapter 11 of Neil Irwin's The Alchemists from 2013. They immediately approved $180 billion of lending, but by December this had amounted to $580 billion, leading to eurojunk sitting on the Fed balance sheet. This was nearly half the increase in the Fed balance sheet. This increase would be gradually worked off over the next six months or so as the agreement in December to purchase $500 in mortgage-backed securities was approved, and these were accumulated as the eurojunk got rolled off.

If Bernanke and crew saved the world, this was the moment, and the parallel with 1931 is precisely that it involved the world economy and financial system. In 1931, the world financial system was already going down the tubes, but the Fed let the US system join it. In 2008, the crisis was emanating from the US and its subrime lending crisis. The Fed effectively kept this from leading to a 1931 outcome in Europe and other nations as well. Why it was kept secret what they were doing (although it was publicly knowable to those following the details of the Fed balance sheet at the time) was that the Europeans, particularly Trichet and those leading the ECB, did not want people to know how fragile their situation was for fear of generating a full-blown panic, which was indeed avoided. People should keep this in mind, even if they think CEOs should have gone to jail or we are about to experience hyperinflation or whatever other dislike they might have about Fed policies of that time.

Re: "In 2008, the crisis was emanating from the US and its subrime lending crisis. The Fed effectively kept this from leading to a 1931 outcome in Europe and other nations as well..."

I have been trying to unravel exactly what happened and still can't understand what went on. But I'll pose a possible (partial) explanation:

The world's financial system has always been incredibly fragile. No system has evolved to ensure equitable access to money or a credible link between the quantity of money versus real wealth on the planet. And this situation has worsened as the world's key energy resource - oil - became concentrated in its supply in a smaller number of places around the globe. This prompted fixes like the creation of the 'petro-dollar' (to maintaiin US economic hegemony). Another fixe was the rationing of oil supplies so that it favoured the most powerful nations (such as the US). As a result economic growth trended much lower post 1970s in Europe versus in the US.

Another fix to sustain economic growth in an unbalanced world economy was to create more and more debt around the world. This provided a mechanism to recycle the abundance (surplus?) of 'petrodollars' but the system was unsustainable as debt repayments in themselves create deflation and recession....

As global debt deflation kicked in global interest rates were lowered. But, since financial wealth was already very concentrated at the top, this fix didn't do much beyond raising asset prices leading to the need for yet higher mortgages. To keep the system afloat official assent was given to subprime lending. After all (they thought) it's not bad debt that creates a financial crisis only a lack of liquidity.

In September 2008 interbank lending closed down. The liquidity crisis finally arrived. After that, the next fix is to print money and lots of it.

Once the printing presses go into play, the next fix is to lower personal incomes-- dramatically to avert inflation.

"....Ponzi austerity is the inverse of Ponzi growth. Whereas in standard Ponzi (growth) schemes the lure is the promise of a growing fund, in the case of Ponzi austerity the attraction to bankrupted participants is the promise of reducing their debt, so as to liberate them from insolvency, through a combination of ‘belt tightening’, austerity measures and new loans that provide the bankrupt with necessary funds for repaying maturing debts (e.g. bonds). As it is impossible to escape insolvency in this manner, Ponzi austerity schemes, just like Ponzi growth schemes, necessitate a constant influx of new capital to support the illusion that bankruptcy has been averted. But to attract this capital, the Ponzi austerity’s operators must do their utmost to maintain the façade of genuine debt reduction." Yanis Varoufakis (former Greek fincance minister, November 2013)

I do not disagree with the statement by Varoufakis that you quote above. The main missing element in your account (and not mentioned by me either) was the rise of the wide variety of ever more leveraged forms of derivatives based on the sub-prime mortgages, with AIG in particular a main supplier of some of the most leveraged to various European banks and other financial institutions, with some of these reported to have had leverage ratios as high as 35 to 1. The upper end of that market has since all but disappeared since the crash.

In any case, it was the collapse of these "shadow bank" securities that was the real nub of the crisis, particularly in Europe, with the banks running to the ECB (and the Bank of England and the Swiss Ntional Bank and the Swedish Riksbank) to save them, but these were unable to. That is when the Fed stepped in quietly with the swaps, but keeping it quiety at Trichet's request so as not to trigger a worse panic and run than was already going on.

Barkley, the leveraged forms of derivatives would likely be a response to a lack of collateral behind the debt being issued. By 'collateral' I refer to 'real' wealth. This problem arose also in the 1920s, prior to the Great Depression. After the Great War, when vast (incalculable) areas of the globe were destroyed along with many millions of young people who had so much potential....as you and most readers are aware.

Again we see even the financiers also are vulnerable to the contingencies of life.

It seems that many holding power are acting inappropriately by leaving people without resources and opportunities to address our shortages of sustainable forms of infrastructure, social services and so on. Perhaps it's because the effective tapping of our human resources challenges the profit structures.